The country has experienced an extended period of crippling deflation, dubbed the lost decades; however, there have been instances over that time when Japanese equity markets made a promising – but inevitably false – start to the year.
Indeed, many market commentators backed Japan heading into 2013 as their contrarian bet for high-growth returns, but they admit they have been taken by surprise by the pace and strength of the recent rally, which has been buoyed on by central bank stimulus measures.
Our data shows that since the start of the year, the Nikkei 225 has returned 25.27 per cent compared with 15.24 per cent from the FTSE All Share.
Performance of indices year to date
Source: FE Analytics
However, as the graph shows, there has been a hefty sell-off recently as investors take profits on those high returns.
Tokyo’s blue chip index lost more than 7 per cent in a single day earlier this month, highlighting the volatility inherent to the market.
Tom Becket (pictured), manager of the Psigma Dynamic Multi Asset fund, was one of the investors who took profits. He told FE Trustnet last week that he was chopping his Japanese exposure as he felt equity markets "had gone too far, too quickly".
"The chief reason behind our – possibly premature – call is that we are now finding it very difficult to assess the fundamentals and valuations of Japanese stocks," he said last week.
"When we last rang our cracked bell calling for better days for Japan, we knew that stocks were cheap."
"Since then, the market has gone parabolic – up some 70 per cent plus from the low – and it is much harder to gauge what price we are paying."
It seems Becket's call was impeccably timed – Japanese markets have pulled back significantly over the following days.
Despite that sell-off, Becket says he needs to see a further correction before he would consider putting that money back into Japanese funds.
"I still think that now is the wrong time to get back into Japan," he commented.
"We reduced our exposure and we will keep it in cash for the time being. We saw another big fall in Japanese equity markets earlier this week, which shows that there are still a lot of nerves out there, so I think it is a bit too risky to up our exposure at this moment in time."
"I think the Nikkei would have to fall to around 13,500 – so about another 4 or 5 per cent – before we would have another look at Japan."
"To a certain extent it is a play on liquidity, but after a meteoric rally like we have seen in Japan over the last few months, I think there will be a profit-taking mentality in Japanese markets for the next couple of weeks."
Becket’s core holding for his exposure to the region is Simon Somerville’s Jupiter Japan Income fund – his eighth-largest position, making up 4.5 per cent of his £20m portfolio.
He also has a satellite holding in Neptune Japan Opportunities.
Becket says that although he has trimmed his exposure to the £625m Jupiter Japan Income fund, it is one of the portfolios he will put money into when he feels there is a good buying opportunity.
Somerville has managed Jupiter Japan Income since its launch in September 2005.
Over that time, the fund has been the fifth-best performing portfolio in the IMA Japan sector, with returns of 48.34 per cent, beating its TOPIX index benchmark by 7 percentage points.
Performance of fund vs sector and index since Feb 2005
Source: FE Analytics
The fund currently has a yield of 2.1 per cent and has had a very similar annualised volatility to both the sector and the index since its inception.
Becket says he will consider adding to Somerville’s fund due to its recent re-orientation.
"The export trade has worked in recent months, but the next leg of the Japanese rally should be a reflation trade of domestic companies," he said.
"Indeed, Simon Somerville of Jupiter fame, our core manager in the asset class, has added to domestic stocks at the expense of the externally facing companies in the last few weeks."
Jupiter Japan Income has an ongoing charges figure (OCF) of 1.75 per cent and requires a minimum investment of £500.
Despite Becket’s hesitance to increase his exposure to Japan, Dean Turner, investment strategist at HSBC Private Bank, says that the medium-term outlook for equity markets still looks rosy.
"We do not think that last week’s market volatility changes Japan’s fundamentals," Turner said.
"The country is only at the beginning of its journey to turn around its economy. Although the jury is still out as to whether 'Abenomics' will succeed, the reforms have already delivered notable successes."
"As we see it, the short-term outlook for Japan is considerably better than it has been for some time."
Turner says that because the yen will not weaken significantly and corporate earnings data has improved, investors should look at Japanese equities as an attractive medium-term proposition.
"Japanese equities have rallied sharply over the past six months, largely as a result of the weakening yen."
"We believe that significant further weakening of the yen is unlikely (even though we expect some moderate weakening), as the negative impact of rising import costs may choke off the nascent recovery," he said.
"Nevertheless, we believe that the outlook for corporate earnings in Japan is relatively constructive, as exporters take advantage of their renewed competitiveness."
"Furthermore, domestically focused firms, especially in the services sector, should continue to benefit from the shift in consumption patterns that an era of positive inflation is likely to bring."
Turner says that this improving outlook for valuations and corporate earnings means Japanese stocks should be able to keep pace with their counterparts in other developed markets in the coming months.
"Although the market experienced a sharp correction towards the end of last week, we believe that this needs to be put in the context of the 80 per cent rally they have enjoyed since November," he continued.
"Japan is only at the beginning of a path to turn around its economy and the jury is still out as to whether the journey will be completed."
"A number of positive steps have already been taken which point to an improvement in the near-term outlook, which should support risk appetite."
